Examining The Bear Case For Diana Containerships

Jan.13.14 | About: Diana Containerships (DCIX)

I have covered Diana Containerships (NASDAQ:DCIX) extensively through the past 18 months, with my most recent coverage (16 Dec 2013) suggesting a 'fair' price target of $5.17 based upon a weighted average of the bear, base, and bull case value assumptions.

Since my article was published, the stock has risen 13.1% (18.2% at peak) versus a comparable S&P 500 gain of 2.9% (3.0% at peak). While I still remain long, and I believe the price is decently attractive for new positions, I am not adding more to my current allocation (roughly 2% of portfolio).

I believe it is prudent for investors to frequently examine their long positions and update their investment thesis/targets as necessary. I will do my best to outline how recent developments pertain to DCIX and why I am increasing my percentage likelihood to the bear case scenario. My new adjusted price target is $4.72.

Scrapping of the Spinel (16 Dec)

In my most recent coverage, I assumed for all cases that both the Spinel (1996-4700 TEU) and the Sardonyx (1995-4700 TEU) would be scrapped in early 2014 for approximately $10M per vessel. I had previously predicted $9M, but independent analysis from VesselsValue.com confirmed the "demolition value" at close to $10M. In the December 16th press release, ironically posted a few hours after my latest article, DCIX announced a sale price of $9.65M coupled with full compensation for early redelivery (worth approximately $1.1M). The redelivery compensation is a nice "bonus" because DCIX avoids multiple days of potential voyage expenses, but at the same time it is surprising that APL [owned by Neptune Orient Lines (OTCPK:NPTOY)] would give up 6 weeks of operation.

While the 6 weeks of early delivery is slightly surprising, the scrapping decisions was easily foreseeable. However, the importance is what the scrapping of an 18 year old vessel signals as Diana's management's expectation of future charter rates. A vessel of this type is typically seaworthy for 30 or more years, with dry dockings conducted approximately every 5 years (15 years of age, 20, 25, etc). Each subsequent dry docking is typically more expensive due to deeper inspection and greater likelihood of necessary repairs; however, vessels have been historically operated in the 25-35 year range.

The scrapping of the Spinel confirms that DCIX is bearish on the prospects for the Panamax container market. The question is-how bearish?

Demolition data from VesselsValue.com has confirmed that scrap prices are still near record highs of $450/LDT (record highs achieved in 2011 at approx. $550/LDT), while the fleet supply/demand picture is still bearish. If these rates persist, scrapping at 15+ might become the new "norm," which is worrisome for the future value of the Hanjin Malta and APL Garnet, but could boost future rates for the Sagitta, Centaurus, Cap Domingo, and Cap Doukato if other companies follow suit. A good bellwether to watch for the industry will be Costamare's (NYSE:CMRE) decision on the Messini (1997- 2500 TEU) and the Marina (1992- 3350 TEU) which come off charter in February 2014 as well as the decisions made on the Karmen and Konstantina (1991/92- 3350 TEU) which came off charter during Q4-13.

Does DCIX management see the need to fully shift away from the Panamax class (doubtful- considering they are still running the Sagitta and Centaurus at an operating loss), or do they simply want to take advantage of large demolition payouts?

Update of the Sagitta Time-Charter (20 Dec)

The Sagitta is a 3400 TEU vessel, built in 2010, which has earned pitiful rates ($7250/day) for DCIX since the original contract ($22k/day until January 2013) expired. In the base case and bull case scenarios, I projected a $9k average for the Sagitta (and sister ship Centaurus) in 2014 and an $11k average for both vessels in 2015.

With the latest charter set at $7400 until November (unlikely to deliver early at these low rates), the $9k target will likely be unachievable. The Centaurus charter (currently at $7500/day) expires between February and June, and the subsequent rates will provide better color.

Flatlining of the 6500 TEU Rates

A critical component of the DCIX base and bull cases involve the scrapping of the Spinel and Sardonyx and the purchase of a 3rd Post-Panamax (6500 TEU) vessel. When DCIX purchased the Puelo and the Pucon (mid-August 2013), the $27,900/day rate was roughly equivalent with the market rates. However, the rates recently collapsed and have hit a low of $14k/day. I expected a slightly speedier recovery into the new year, but as of last week the rates are still around $15k/day.

Click to enlarge

If these rates do not recover during the first-half of 2014, DCIX will have to consider a strategy shift. This could consist of either a purchase of a larger class (8000+ TEU) vessel, which will result in higher dilution and net debt, a return to the destructive above-market leaseback strategy (loss of true equity amidst dilution), or a decision to wait-and-see (smartest move, but results in 0% return on assets).

Relevant Rates to Watch

I've received several inquiries from readers who often confuse shipping rates between various tanker, container, and dry bulk vessels, so I'm including a chart below, with 5-10 year data taken from the Harper Petersen & Company container index (HARPEX).

As the chart demonstrates, shipping rates collapsed in 2008 and saw a brief recovery in 2010. The 6500 TEU (purple) has performed much better than that 3500 TEU (BLUE) class, but is still struggling.

To keep relevant rates in mind, the base case calls for 3500 TEU rates of $15k and 6500 TEU rates of $27.75k for 2016 onwards. The bull case calls for $25k and $35k respectively.

Click to enlarge

Target Update

While I am unsurprised by the scrapping of the Spinel, the early delivery is slightly surprising (bearish) and the low rate for the Sagitta is also slightly lower than expected. I am revising my target to reflect a higher percentage of the bear case occurring (15%/65%/20%), which results in an updated price target of $4.72. The previous price target was $5.17.

Investment Recommendation

Based on the current "fair" upside of 18.6%, I still recommend DCIX as a good speculation play on the containership market, but I will not be adding additional shares to my position. If DCIX drops back below $3.50, I would once again consider it a 'strong buy.'

Disclosure: I am long DCIX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.